Publications
Partners
EXCHANGE-TRADED funds (ETFs) are certainly all the rage at the moment overseas, growing by an average annual rate of 40% in the past decade to about $1 200bn in assets this year.
An ETF is a bit like a share, but also a bit like a unit trust. It pools together many investors' money to buy a number of assets, but unlike unit trusts it is listed on the stock exchange and you can trade it like shares.
Most ETFs are index trackers - they basically just reflect the performance of an index. The Satrix 40 fund, for example, tracks the FTSE/JSE Top 40 Index – a list of the 40 biggest companies on the local market. Your money will only buy these shares according to their weighting in the index. (If Anglo is bigger than MTN, less of your money will go towards MTN Group [JSE:MTN].)
The main selling point of ETFs for many people is the cost.
Because an ETF usually just tracks an index or is based on a mathematical model, no crack team of Merc-driving fund managers needs to be employed to decide where your money will grow best. And unlike unit trusts or other investment products, ETFs are listed on the market like shares and a sales force of intermediaries doesn't need to be employed.
While the total expense ratio (TER – the percentage of your money which goes towards costs) of a typical SA unit trust would be around 1.5%, the TER of an ETF will be less than 0.5%.
This doesn't sound like a big difference, but in the long run could make a huge change. Take an investment of R10 000 which provides a yield of 10% a year. If your costs run into 1.5% every year, you will have R49 700 after an investment of 20 years. Lower the cost to 0.5% and you have R60 800.
ETF market hots up
In South Africa, the demand for these funds grew by 21% last year – but ETFs only represent less than 4% of the collective investments industry. All of the local ETFs together are still smaller than some of the largest unit trusts, like the Absa money market fund, on their own.
This is in part because ETFs in SA are still not cheap enough, says Cobie Legrange, investment analyst at the financial advice group acsis. He thinks ETFs in SA still look expensive compared to those elsewhere, with the costs of some funds in the US below 0.1%.
But Mike Brown, managing director of etfSA.co.za, a website dedicated to ETFs, says that the average TER of about 3 500 global ETFs, listed on stockmarkets around the world, is about 0.5% per annum. "South African ETFs, which are still relatively small, offer good comparable value with similar-sized ETFs worldwide."
What needs to come down, says Brown, are the costs of local actively managed unit trusts, which can often run to 3% to 4% per annum when performance fees are taken into account.
Legrange expects ETF prices to come down, with a price war already brewing in ETFs which track the biggest 40 shares in the market.
The ETF market is also hotting up in other ways, with new entrants which now allow you to track oil and coal prices (RMB exchange-traded notes), property and even the money market.
The market is also increasingly moving towards "smart" passive – funds that don't only track JSE indices, but also dig a bit deeper. Take the Satrix Divi Plus fund – which beat all unit trusts to deliver the best performance over the past three years. It only invests in the 30 companies on the JSE that pay the best dividends.
Absa will also this month launch the country's first ETFs which invest in a number of assets – including equities, bonds, cash and the money market. They aim to replicate asset allocation unit trusts, a favourite among investors who want to diversify their assets, but at a much cheaper price with a maximum of 0.8% for retail investors, compared to similar unit trusts that ask 2%.
Active or passive? You decide
And new investment platforms like ETFSA.co.za now allow small investors to invest in any ETF for as little as R300 a month or for lump sums from R1 000. Investments are bulked together to lower brokerage fees, and the etfSA platform also allows reinvestment of dividends switching between ETFs within a low annual management fee.
Whether you go the passive or active route depends on your investment beliefs, says Legrange.
Do you believe investment returns are only driven by the economy (which grows companies and therefore profits)? Or do you think the driver is the economy as well as valuation (that the market sometime misprices assets, which can be exploited by fund managers)?
Legrange usually poses these questions to his clients, in an attempt to find out what their investment philosophy is.
Many analysts think that mispricing of assets is getting harder due to more stringent financial reporting requirements and the more efficient flow of information. Research shows that only 20% of SA unit trusts beat their benchmark indices over the past one to seven years, making a strong argument for investors to choose less risky passive instruments such as ETFs.
But there are also those unit trust managers who are great at stock picking through their understanding of sentiment and behaviour, says Legrange. While the market is getting more efficient, it is still driven by emotion in the short term – and fund managers who can spot where share prices have moved away from their fair values should in the long run beat their benchmarks and by default passive investments.
If you are happy to track an index which performs better than most unit trusts but may not deliver the best performance, you may opt for index trackers like ETFs.
But if you believe that a better share selection will grow your money better, and if you have an opinion on where the market is heading and which sectors should do well, go active.
Match your manager to your beliefs
Many investors are now opting to use "core/satellite" strategies, says Brown. They use ETFs for the bulk of their investments (core), and risk smaller portions of their investments to selected active managers (satellite) who look for outperformance of the benchmarks.
If you don't want to buy shares directly, consider finding a unit trust fund manager who holds beliefs similar to yours, Legrange says. Go through the mandates of different unit trusts to find a fund manager who you feel comfortable with. (You will find information on fund managers on sites like www.equinox.co.za.)
“For example, if you know that buying mispriced companies in the long run will provide superior returns as their price performance catches up with the market, you are probably what is called a value investor. Find those managers who hold the same belief as you for a more comfortable investment experience,” says Legrange.
ETFs have received some bad press in recent times, with the British authorities warning of "potential financial stability issues arising from recent trends in exchange-traded funds". This is because some of the new ETFs are borrowing money (using leverage) to invest in assets, or buying risky loans.
Amelia Morgenrood, portfolio manager and director at PSG Konsult, cautions investors to ensure that they know exactly what they are investing in when choosing an ETF.
"If you buy an ETF on a foreign market, you need to be extremely careful because many of the ETFs may not always be what you think they are. Some are sophisticated and complex products which may be invested in derivatives.
"For investors who are not that well informed, it will be better than to invest in more than one ETF to spread the risk."
According to a recent report, these "synthetic ETFs" now represent 45% of the European ETF market.
- Fin24
An ETF is a bit like a share, but also a bit like a unit trust. It pools together many investors' money to buy a number of assets, but unlike unit trusts it is listed on the stock exchange and you can trade it like shares.
Most ETFs are index trackers - they basically just reflect the performance of an index. The Satrix 40 fund, for example, tracks the FTSE/JSE Top 40 Index – a list of the 40 biggest companies on the local market. Your money will only buy these shares according to their weighting in the index. (If Anglo is bigger than MTN, less of your money will go towards MTN Group [JSE:MTN].)
The main selling point of ETFs for many people is the cost.
Because an ETF usually just tracks an index or is based on a mathematical model, no crack team of Merc-driving fund managers needs to be employed to decide where your money will grow best. And unlike unit trusts or other investment products, ETFs are listed on the market like shares and a sales force of intermediaries doesn't need to be employed.
While the total expense ratio (TER – the percentage of your money which goes towards costs) of a typical SA unit trust would be around 1.5%, the TER of an ETF will be less than 0.5%.
This doesn't sound like a big difference, but in the long run could make a huge change. Take an investment of R10 000 which provides a yield of 10% a year. If your costs run into 1.5% every year, you will have R49 700 after an investment of 20 years. Lower the cost to 0.5% and you have R60 800.
ETF market hots up
In South Africa, the demand for these funds grew by 21% last year – but ETFs only represent less than 4% of the collective investments industry. All of the local ETFs together are still smaller than some of the largest unit trusts, like the Absa money market fund, on their own.
This is in part because ETFs in SA are still not cheap enough, says Cobie Legrange, investment analyst at the financial advice group acsis. He thinks ETFs in SA still look expensive compared to those elsewhere, with the costs of some funds in the US below 0.1%.
But Mike Brown, managing director of etfSA.co.za, a website dedicated to ETFs, says that the average TER of about 3 500 global ETFs, listed on stockmarkets around the world, is about 0.5% per annum. "South African ETFs, which are still relatively small, offer good comparable value with similar-sized ETFs worldwide."
What needs to come down, says Brown, are the costs of local actively managed unit trusts, which can often run to 3% to 4% per annum when performance fees are taken into account.
Legrange expects ETF prices to come down, with a price war already brewing in ETFs which track the biggest 40 shares in the market.
The ETF market is also hotting up in other ways, with new entrants which now allow you to track oil and coal prices (RMB exchange-traded notes), property and even the money market.
The market is also increasingly moving towards "smart" passive – funds that don't only track JSE indices, but also dig a bit deeper. Take the Satrix Divi Plus fund – which beat all unit trusts to deliver the best performance over the past three years. It only invests in the 30 companies on the JSE that pay the best dividends.
Absa will also this month launch the country's first ETFs which invest in a number of assets – including equities, bonds, cash and the money market. They aim to replicate asset allocation unit trusts, a favourite among investors who want to diversify their assets, but at a much cheaper price with a maximum of 0.8% for retail investors, compared to similar unit trusts that ask 2%.
Active or passive? You decide
And new investment platforms like ETFSA.co.za now allow small investors to invest in any ETF for as little as R300 a month or for lump sums from R1 000. Investments are bulked together to lower brokerage fees, and the etfSA platform also allows reinvestment of dividends switching between ETFs within a low annual management fee.
Whether you go the passive or active route depends on your investment beliefs, says Legrange.
Do you believe investment returns are only driven by the economy (which grows companies and therefore profits)? Or do you think the driver is the economy as well as valuation (that the market sometime misprices assets, which can be exploited by fund managers)?
Legrange usually poses these questions to his clients, in an attempt to find out what their investment philosophy is.
Many analysts think that mispricing of assets is getting harder due to more stringent financial reporting requirements and the more efficient flow of information. Research shows that only 20% of SA unit trusts beat their benchmark indices over the past one to seven years, making a strong argument for investors to choose less risky passive instruments such as ETFs.
But there are also those unit trust managers who are great at stock picking through their understanding of sentiment and behaviour, says Legrange. While the market is getting more efficient, it is still driven by emotion in the short term – and fund managers who can spot where share prices have moved away from their fair values should in the long run beat their benchmarks and by default passive investments.
If you are happy to track an index which performs better than most unit trusts but may not deliver the best performance, you may opt for index trackers like ETFs.
But if you believe that a better share selection will grow your money better, and if you have an opinion on where the market is heading and which sectors should do well, go active.
Match your manager to your beliefs
Many investors are now opting to use "core/satellite" strategies, says Brown. They use ETFs for the bulk of their investments (core), and risk smaller portions of their investments to selected active managers (satellite) who look for outperformance of the benchmarks.
If you don't want to buy shares directly, consider finding a unit trust fund manager who holds beliefs similar to yours, Legrange says. Go through the mandates of different unit trusts to find a fund manager who you feel comfortable with. (You will find information on fund managers on sites like www.equinox.co.za.)
“For example, if you know that buying mispriced companies in the long run will provide superior returns as their price performance catches up with the market, you are probably what is called a value investor. Find those managers who hold the same belief as you for a more comfortable investment experience,” says Legrange.
ETFs have received some bad press in recent times, with the British authorities warning of "potential financial stability issues arising from recent trends in exchange-traded funds". This is because some of the new ETFs are borrowing money (using leverage) to invest in assets, or buying risky loans.
Amelia Morgenrood, portfolio manager and director at PSG Konsult, cautions investors to ensure that they know exactly what they are investing in when choosing an ETF.
"If you buy an ETF on a foreign market, you need to be extremely careful because many of the ETFs may not always be what you think they are. Some are sophisticated and complex products which may be invested in derivatives.
"For investors who are not that well informed, it will be better than to invest in more than one ETF to spread the risk."
According to a recent report, these "synthetic ETFs" now represent 45% of the European ETF market.
- Fin24
